Successful Stock Trading - a Guide to Profitability

64 Pages·2012·2.53 MB·English

by  Nick Radge

This extract from Adaptive Analysis for Australian Stocks by NickRadge was
first published in 2006 by Wrightbooks. Extract has been updated and
published in 2012 by Radge Publishing.
© Nick Radge 2012. All rights reserved. You may copy, distribute and
transmit this material in its original format. You may not alter, transform
or build upon this work.
Radge Publishing
PO Box 721 Noosa Heads QLD 4567 Australia.
www.radgepublishing.com
ISBN: 9780980871241 (EBook)
Cover design: Zach Radge
Disclaimer:
The material in this publication is of the nature of general comment only and does not
represent professional advice given by the publisher. It is not intended to provide specific
guidance for your particular circumstances and it should not be solely relied upon as the
basis for any decision to take action or not take action on any matter for which it covers.
While the Author is a licensed financial professional, the publisher advises readers to
obtain professional advice where appropriate and which considers your exact situation,
before making any such decisions. The publisher makes no representation or warranties
with respect to the accuracy, applicability, fitness, or completeness of the contents.
EVERY EFFORT HAS BEEN MADE TO ACCURATELY REPRESENT THIS METHOD AND ITS
POTENTIAL. THERE IS NO GUARANTEE THAT YOU WILL EARN ANY MONEY USING THE
TECHNIQUES AND IDEAS IN THIS EBOOK. EXAMPLES IN THIS EBOOK ARE NOT TO BE
INTERPRETED AS A PROMISE OR GUARANTEE OF EARNINGS. EARNING POTENTIAL IS ENTIRELY
DEPENDENT ON THE PERSON. THE PUBLISHER DOES NOT PURPORT THIS AS A ‘GET RICH
SCHEME’. ALL COMMENTS AND/OR METHODS PRESENT ARE NOT SPECIFICALLY ENDORSED OR
PROMOTED DIRECTLY BY THE PUBLISHER AND ANY LIABILITY RELATING FROM SUCH IS HEREBY
WAIVED AGAINST THE PUBLISHER.

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Important Information
This book may contain advice that has been prepared by Reef Capital
Coaching (AFSL 288200). Being general advice it does not take into
account your objectives, financial situation or needs. Before acting on this
general advice you should therefore consider the appropriateness of the
advice in regard to your situation. We recommend you obtain financial,
legal and taxation advice before making any financial investment
decisions.
This material has been prepared based on information believed to be
accurate at the time of publication. Subsequent changes in circumstances
may occur at any time and may impact the accuracy of the information.
Past results are not a reliable indication of future performance.
All results are considered to be hypothetical unless otherwise specified.
Hypothetical performance results have many inherent limitations. Unlike
an actual performance record, simulated results do not represent actual
trading. Also, since the trades have not actually been executed, the results
may have under or over compensated for the impact, if any, of certain
market factors, such as lack of liquidity.

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Contents

INTRODUCTION ............................................................................................ 4
CHAPTER 1 - AIMS ......................................................................................... 7
CHAPTER 2 - SKEWING THE NUMBERS TO WIN ......................................... 20
CHAPTER 3 - ENTRIES, FREQUENCY AND MIND-SET. .................................. 31
CHAPTER 4 - RISK MANAGEMENT .............................................................. 43
CONCLUSION AND FURTHER READING ...................................................... 56
BONUS: FREE 2 week trial to The Chartist .................................................. 57
APPENDIX A - STOPS AND LONG TRADING ................................................. 58
APPENDIX B - STOPS AND SHORT TRADING ............................................... 61

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INTRODUCTION

This e-book is designed to show you an alternative way of looking at
profitability and your own trading. My reputation in the retail marketplace
is as a specialist in risk management and systematic trading strategies.
While systematic trading may sound complicated to the new trader, it
simply means a strategy that is defined by very specific rules – rules to
define the trend, enter and the market and manage risk. This is the way I
have always traded and I am happy to share my insights into trading the
global markets.
I deal with technical analysis rather than fundamental analysis. It's my
belief that the picture of a stock's current price action and price history
cannot be disputed – it is a 100 per cent certainty. A company's balance
sheet, earnings and disclosures, however, can be disputed. Bear Sterns,
Lehman Brothers, MF Global and Enron are some better known and recent
examples where many fundamental analysts got it plain wrong and,
unfortunately, investors paid the price for the poor analysis. Other
examples are just as bad and I collected a huge number of examples in the
early 2008 deluge of earnings downgrades. We can see the same trend of
poor disclosure throughout the world. While an in-depth look at all of
these examples is beyond the scope of this book, suffice to say I believe
the reliance of many analysts on company disclosures is questionable.
I readily accept that the application of both types of analysis is equally
subjective. In order to establish a fair valuation for a stock, a fundamental
analyst must make assumptions on future earnings growth and other
contributing factors, such as the expected period of growth, non-growth
periods and benchmark interest rates. Once these assumptions have been
plugged into analysts' models, the resulting valuations vary considerably.
These valuations are easily accessible by reviewing consensus data.
However, the same applies for the technicians. The way one pattern is
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read can vary among analysts. In this area, I see technical analysis and
fundamental analysis standing side by side.
However, the main benefit of technical analysis over fundamental analysis
is that the charts provide a very specific right or wrong point where
protective stops can be placed and monetary losses can be limited. As
you'll see shortly, the limitation of losses is paramount to the success of a
trader and an investor, both financially and psychologically.
People may be forewarned of situations such as the collapses of Bear
Sterns and Enron by the deteriorating price action. Knowing when one is
wrong using fundamentals, though, is a very grey area. Depending on the
style of analysis employed, the lower a share price goes below its
valuation may mean the better value the stock becomes. On the other
hand, it may mean the valuation was incorrect to begin with. It's a hard
ask for any analyst to amend his or her analysis and valuation in the face
of a plunging share price – they are usually only forced do so after the fact
and after the monetary damage is done.
At the time of writing, I've been trading and investing since 1985, a total of
26 years, or just over half my lifetime. I have personally traded many
global instruments; from stocks to bonds, from commodities to foreign
exchange and ETFs. In the early 1990s, I worked in the pits of the Sydney
Futures Exchange. Later, in the mid-1990s, I worked in dealing rooms in
London and Singapore before starting a hedge fund in 1998. In 2001, with
advancing regulatory conditions, I decided to move to another investment
bank where I became an associate director and managed accounts using
systematic trading approaches built around technical analysis.
It was in the day-to-day dealing with retail clients that I realised the
extreme psychological factors that play havoc with their decisions. The
need to almost always be correct, the inability to realise when analysis is
wrong and then to take the appropriate action to defend an account, the
fear of losing money, the over-reliance on unproven theories, or any
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mundane theory for that matter – all are products of psychology, and the
list goes on. However, one factor clearly stood out above all others to
create the most havoc – not understanding that profits can be generated
regardless of what tools or analysis are used.
This ebook is about understanding how to make profits.
As we've moved further into the era of self-managed capital and personal
responsibility for one's own financial affairs, it has always been
pleasurable to hear how my analysis has made at least a small difference.
On a final note, remember – there is more to life than trading. The
markets and the opportunities found within them will always be there
tomorrow.
Nick Radge
www.thechartist.com.au

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CHAPTER 1 - AIMS

Your aim is to be profitable.
My aim is to help you understand how to make yourself profitable.
There may not appear to be a profound difference in the above
statements, but let's remember that the vast majority of traders, and
active investors for that matter, are losers – or, at best, marginal winners.
Some people pay educators up to $20000 to help them find an edge or the
secret to generating profits in the markets. They listen to poor advice,
perhaps from non-licensed practitioners, and rarely take any responsibility
for their own actions. If you are like many other beginners, you probably
already feel as though you've been through the ringer, trying many
different methods and reading any book you could get your hands on. I
call this the beginner's cycle – moving back and forth between methods
and ideas that just never eventuate into any concrete or consistent profits.
It can be an expensive and long journey but, more importantly, it's an
extremely frustrating journey that causes many to give up.
While finding a trading or investing style that suits you is important, it is
more important to understand and accept why profitability occurs. I say
'accept' because what I put forward here is usually dismissed for
simplifying a so-called complex concept. But simple works through thick
and thin, good and bad. (Of course, psychology is also extremely
important; however, as I am not an expert in that field, I won't be
exploring that side of the equation in too much depth.)
What I would like to do is to realign the thinking processes that most likely
operate within you. To start with I'll work through a few issues and
hopefully get you thinking differently about them. What I'd like you to do
as you read through is ask questions of yourself and those in the trading
community you may have come in contact with. Rather than simply
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agreeing or disagreeing with my points, see if you can actually relate to
them and understand the consequences of my arguments. Trading is
about opening your mind to possibilities. After 26 years in the markets I
am still learning, still researching and still passionate. Passion is the most
important thing to develop – from there, profitable trading will flow to
you.
Trading tools and indicators
If we placed 100 consistently profitable traders in a room and asked each
to discuss his or her trading style and techniques in five sentences or less,
in my experience, whilst each person would use different tools and styles,
they would all be trying to achieve the same goal – that is, to generate
profits.
Every time you speak with another trader (regardless of whether he or she
is successful), every time you read a trading book, every time you receive
advice, there will always be new information to take in – usually about an
entry technique, or a new style, method or indicator. Everyone has an
opinion. There are many successful traders – or at least people who have
had just one profitable trade – and they have achieved this success even
though they all use different tools and techniques.
Out of our sample of 100 consistently profitable traders, 40 may use
fundamental analysis, 40 may use technical analysis and 20 may just use
intuition or gut feel. Even then, the 40 who use fundamental analysis may
use different aspects of that field. Some may rely on various ratios, while
others may not take any ratios into account and rely solely on insider
activity. The list and combinations are infinite.
Of the technical traders, some will rely on moving averages, some on an
RSI or other indicator, while others will rely only on price patterns and
volume. Yet again, the pieces to the puzzle can be infinite. My point is that
each profitable trader will use a different technique, style, investment
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time frame, information sources and tools. If all of the 100 traders are
profitable through using different techniques, the common denominator
cannot be the tools being used. It must be something else. Think about
four profitable traders or investors who you know or have read about.
Think about Buffett or Soros. Think Tudor Jones. Are they the same in their
approach? Their tools, their time frames, their objectives? Of course not.
So I reiterate the common denominator must be something else.
If you agree with the above, it becomes easier to suggest that it will not
matter which indicator, tool, time frame or software package is superior,
and it's certainly not a tightly held secret or insider knowledge that makes
them all profitable. All indicators, all technical analysis techniques, all
fundamental analysis techniques, all software – everything you use to
trade and invest – are nothing but tools.
The tools you use to trade do not maketh the money!
Let me use a simple non-trading analogy, shown in table 1.1.
Table 1.1: trading versus travel analogy
Travel Trading
Goal Get from point A to point B Be profitable
Tool Car, Boat, Plane, walk, train Technical analysis, fundamental
analysis, guess work

Our first non-trading goal is to travel from point A to point B. The tool to
achieve that goal can be any mode of transport, such as a car or boat. As
you are well aware, there are many kinds of cars and boats and when
choosing one, our decision is largely based on our personality and financial
circumstances. The same goes for trading. The goal of trading is to be
profitable. The tools used to achieve this will vary depending on our
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